Suffering from a cost disease

Date posted: December 6, 2012

There are certain parts of our economy — such as health care and education — where prices seem to be rising consistently faster than in other sectors. Is there a fundamental economic reason behind this? N.C. State University economist Mike Walden responds.

“About 30 years ago a very smart economist named William Baumol actually noted this, because this has not been a new trend. We have seen, in areas like health care and education, prices rising faster. He noticed this, and he coined the term cost disease. And he argued those sectors suffered from something, again, he called cost disease.

“Here’s what he means: Think, he said, think of the economy in two sectors: One sector where it’s very easy to increase the productivity of workers — manufacturing would be a good example, where every year workers who are teamed with better technology, better machinery, can produce more. We don’t need as many workers there, but they’re paid more because they can do more per hour. However, there are other sectors, he argues, and healthcare and education would be a good one, where they’re not as prone to have the advantages of productivity improvements because they tend to be very labor-intensive sectors. For example, think of, if you’re in a hospital, you want to see a live nurse. You don’t want some machine or robot attending you. So, he said, (in) these sectors, it’s very hard to squeeze out productivity improvements, but they still have to attract workers that have to take competitive wages, and so they have to pay the same wages as those workers in the productive sectors. Therefore, that causes those sectors to see big increases in their prices, because they don’t have the advantages of those productivity improvements.

“He argues that this has been long with us. It’s nothing new. And he also argues we can actually absorb this. We can handle this cost disease, as long as the savings that we have in the productivity-enhancing sectors are enough to pay for the higher prices we have to pay in those sectors where we don’t get those productivity gains.”

About Economic Perspective:

Economic Perspective, featuring N.C. State University economist Mike Walden and host Mary Walden, focuses on economic issues facing North Carolina and the nation. The 1- to 2-minute segments are issued each week day.

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